OUTLINE
NOTATION
PV
: Present value
DOUBLING PERIOD
Thumb Rule : Rule of 72
72
Doubling period =
Interest rate
Interest rate : 15 percent
72
Doubling period =
= 4.8 years
15
A more accurate thumb rule : Rule of 69
69
Doubling period =
0.35
Interest +
rate
Interest rate
: 15 percent
69
Doubling period = 15
= 4.95 years
0.35
1,000
1,100
Third year:
Principal at the beginning
Interest for the year
(Rs.1,210 x 0.10)
121
Principal at the end
1,331
1,210
FORMULA
FUTURE VALUE = PRESENT VALUE (1+r)n
6%
8%
10%
12%
14%
0.890
0.857
0.826
0.797
0.770
0.792
0.735
0.683
0.636
0.592
0.705
0.630
0.565
0.507
0.456
0.626
0.540
0.467
0.404
0.351
10
0.558
0.463
0.386
0.322
0.270
12
0.497
0.397
0.319
0.257
0.208
A2
+ +
(1 + r)2
An
(1 + r)n
At
(1 + r)t
Year
Cash Flow
PVIF12%,n Present Value of
Rs.
Individual Cash Flow
1
2
3
4
5
6
7
8
1,000
2,000
2,000
3,000
3,000
4,000
4,000
5,000
0.893
0.797
0.712
0.636
0.567
0.507
0.452
0.404
893
1,594
1,424
1,908
1,701
2,028
1,808
2,020
13,376
1
1,000
1,000
1,000
5
1,000
1,000
+
1,100
+
1,210
+
1,331
+
1,464
Rs.6,105
A [(1+r)n1]
r
annuity =
1

6%
1.833
8 % 10 % 12 % 14 %
1.783 1.737 1.690 1.647
Q1. You want to buy a house after 5 years when it is expected to cost Rs 2
million. How much should you save annually if your savings earn a
compound return of 12 %.
Q2. Futura Ltd has an obligation to redeem Rs 500 million bonds 6 years
hence. How much should the company deposit annually in a sinking fund
account wherein it earns 14 % interest to cumulate Rs 500 million in 6
years time?
Q3. A finance company advertises that it will pay a lump sum of Rs 8,000
at the end of 6 years to investors who deposit annually Rs 1000 for 6
years. What interest rate is implicit in this offer ?
Q4.Suppose you have decided to deposit Rs.30,000 per year in your Public
Provident Fund Account for 30 years. What will be the accumulated
amount in your Public Provident Fund Account at the end of 30 years if the
interest rate is 11 percent?
Q5.
You want to take a trip to the moon which costs
Rs 10,00,000 The cost is expected to remain
unchanged in nominal terms. You can save
annually Rs 50,000 to fulfill your desire. How long
will you have to wait if your savings earn an
interest of 12 % p.a
Q4.
50,000 x FVIFAn=?,12% = 10,00,000
You will have to wait for about 11
years.
Installment
(1)
3 681,129
484,986
Interest
Repayment
(2)
1 10,00,000
851,688
2
681,129
Annual
(3)
298,312
851,688
Balance
(2)(3) = (4)
(1)(4) = (5)
150,000
298,312
298,312
Principal
148,312
127,753
170,559
102,169
4 484,986
259,422
298,312
727,482
5 259,422
298,312
38,913
196,143
225,564
259,399
23
Q5
PV A = A * [ 1 
1 / ( 1 + r ) n]
r
10,00,000 = A [ 1 1 / ( 1.01 )
180
0.01
A = Rs 12,000
Q6. PVA = 12000 * [ 1  1 / ( 1 + 0.015 )
36
0.015
= 12000 * 27.66
=
331920
0.12
N= 12 years
A(1 + g)2
A(1 + g)n
n
Q8
PV of teak =
500 * 1,00,000 ( 1 + 0.08 ) [ 1 ( 1 +
0.08 ) 20 ]
(1 +
0.15 ) 20
0.15
0.08
= Rs 55,17,36,683
A
Present value of perpetuity =
r
Example
The present value of a perpetuity of
Rs 10000 if interest rate is 10 % :
PV = 10000/ 0.10 = Rs 100000
SHORTER
COMPOUNDING
PERIOD
1 +
m*n
EFFECTIVE
VERSUS
NOMINAL RATE
r = (1+k/m)m 1
r = effective rate of interest
k = nominal rate of interest
m = frequency of compounding per year
Example : k = 8 percent, m=4
r = (1+.08/4)4 1 = 0.0824
= 8.24 percent
Nominal and Effective Rates of Interest
Effective Rate %
Nominal
Annual
Monthly
Rate %
Compounding
Compounding
8
8.00
8.16
12
12.00
Semiannual
Compounding
Quarterly
Compounding
8.24
12.36
8.30
12.55
12.68
SUMMING UP
Money has time value. A rupee today is more
valuable than a
rupee a year hence.
The general formula for the future value of a
single amount
is :
Future value = Present value (1+r)n
The value of the compounding factor, (1+r)n,
depends on the
interest rate (r) and the life of the
investment (n).
According to the rule of 72, the doubling
period is obtained
FV = PV ( 1+ r ) n
FV = PV * FVIF ( r , n )
PV = FV *
1 / ( 1+ r ) n
PV = FV * PVIF
(r,n)
FVAn = A * [ ( 1 + r )n
 1]
r
FV A
= A * FVIFA
(r,n)
PV An
A * [ 1
PV An
A * PVIF
1 / ( 1 + r )n ]
r
(r,n)
FV of compounding period = PV ( 1+ r )
m*n
m
R
[1+ k]
m
 1
PV of growing annuity =
A ( 1+ g ) *
[ 1
PV of perpetuity =
( 1+ g ) n ]
( 1 + r )n
( rg )
A
r